Section 45E of the tax code permits an eligible small employer to claim a tax credit versus a deduction for qualified startup costs and plan administration fees. The credit is 50 percent of the relevant expenses and is limited to $500 per year for the first credit year and each of the following 2 tax years. The credit is currently set to expire at the end of 2012; however, it has previously been extended.
For example, if such an employer paid $1,200 in fees to establish a new plan in 2011, and then paid $800 in plan administration fees in 2012, the allowable tax credit would be $500 in 2011 and $400 in 2012. Thus, the real cost to establish the plan is reduced from $1,200 to $700 because of the $500 tax credit.
An eligible small employer is one who had no more than 100 employees during the tax year preceding the first credit year and only employees who were paid more than $5,000 during that tax year are counted. Further, as the credit is intended to spur the adoption of new plans, if an otherwise eligible employer established or maintained a plan during the 3 tax years preceding the first credit year, they are not eligible to claim the credit.
Qualified startup costs are not only the expenses incurred to establish or administer an eligible employer plan; they include the retirement-related education of employees about the plan. Also, the first credit year can be the year before the plan becomes effective as long as the expenses were paid or incurred in that year. Therefore, fees paid in 2011 to set up a new plan effective in 2012 count.
Lastly, an eligible employer plan includes a profit sharing plan, a Section 401(k) plan, a defined benefit plan, and certain SEPs and SIMPLEs. And they must include at least one employee eligible to participate who is not considered to be a highly-compensated employee (defined as a 5 percent owner in the current or preceding year or who received at least $110,000 in pay during the most recent prior year).
Jay H. Beltz is PBTK’s Pension Plan Services Practice Leader. Jay is a pension consultant with more than 25 years designing, administering and consulting on tax-qualified retirement programs like defined benefit plans and Section 401(k) plans. He has been involved in establishing and terminating more than 5,000 plans and continues to advise all sizes of employers about the tax and savings benefit of such programs for their employee’s financial well-being. He can be reached at email@example.com.